Finding the right home loan

Finding a home loan is one of the biggest financial decisions we make, but many people spend less time finding the right mortgage than on planning a holiday. Not doing the homework to find the right mortgage could cost thousands of dollars in extra interest over the life of the loan.

You wouldn't think a small difference in interest rates could make that much difference on how much is repaid, but it adds up.

The reason is the power of compounding. Just as an investment grows if the interest it pays is added to the capital, the same thing happens with the mortgage, but in reverse.

Shop wisely … a mortgage with the lowest rate may not be the best loan. Illustration: Karl Hilzinger

To show the difference a small gap in interest rates can make I used the MoneySmart mortgage calculator provided by the Australian Securities and Investments Commission at moneysmart.gov.au.

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I assumed a mortgage of $350,000 that is paid back over 25 years with monthly repayments.

If the interest rate is 6 per cent the amount repaid in interest is $326,516. If the interest rate is 5.5 per cent, the amount repaid in interest falls to $294,792, or a difference of $31,724 between the two interest rates.

However, the mortgage with the lowest interest rate may not necessarily be the best loan. Fees and charges can add thousands to the cost of a loan. All lenders are required to provide the ''comparison rate'' alongside their advertised rates.

The comparison rate is based on a loan of $150,000 and a term of 25 years. It is a good attempt to capture the fees and charges of the loan and express those costs through the interest rate.

It captures most of the costs, but not all. For those who prefer to have help, mortgage brokers can be good. While they can help take the legwork out of finding the best mortgage, it does not remove all responsibility from the borrower. A good broker will have a spread of loans from various lenders and will recommend more than one mortgage. Brokers are paid a commission by the lenders at a time when commissions for financial planners, for example, are on their way out.

There is usually an upfront payment for signing a client and an ongoing trial commission, which is a percentage of the loan size. The larger the mortgage the larger the commission, so be wary of being advised by a mortgage broker to borrow more than is needed.

Some lenders pay higher commissions on their mortgages than other lenders. Brokers have to be licensed and with that comes better disclosure of commissions and ''volume'' payments, if any, where the broker is paid more by the lender for selling more of its mortgages. Brokers also have to conduct an assessment as to whether the mortgage is ''not unsuitable'' for the borrower.

That is much better than the bad old days but borrowers should also check directly with lenders to see what is on offer or with comparison websites such as canstar.com.au or ratecity.com.au.